These two items are one of the many aspect of risk and it relates to the cause of losses:
- A peril can be defined as that which gives rise to a loss.
- A hazard can be defined as that which influences the operation of the peril.
At first, the distinction between the two may not be that obvious. However, the following example should help.
Example: consider a thatched cottage which is insured by a specialist thatch insurance underwriter as most standard home insurers will not offer cover for properties that are build of a standard construction. This risk of fire is one of the components that are insured under this policy. Fire is the prime cause that will give rise to a loss, but the thatched roof makes the fire spread more quickly and do more damage, if a fire does occur. Fire is, therefore, the peril and the thatched roof is the hazard.
Hazards are classified as physical or moral. Physical hazard relates to the dimensions and physical characteristics of the risk. For example, the better the standard of building construction the lower the physical hazard for fire and similar risks, as the building will be more resistant to damage. Buildings used as warehouses that are constructed entirely of metal, concrete and other non-combustible materials will constitute a low fire risk to the warehouse insurance underwriter.
Moral hazard arises from the attitude and conduct of people. In insurance, this is usually the conduct of the person insured. However, the conduct of the insured’s employees and that of society as a whole are also aspects of moral hazard.
Sometimes it can be difficult to distinguish between physical and moral hazard. Take the example of the high value sports car. If you are an insurer who is insuring the driver against the risk of injuring someone, the car itself is not a moral hazard; the manner in which it may be driven is the moral hazard.